Downturn in Eurozone Fuels Bets on September ECB Pause
In Germany, overall economic activity declined at the fastest pace since the first wave of the pandemic, in May 2020.
The contraction of private-sector activity in the Eurozone has intensified, leading investors to bet that the European Central Bank (ECB) will pause its campaign of interest-rate hikes next month.
Services in August ceased being a bright spot and followed the industrial sector into a downturn in the region’s top two economies, prompting the shift in market wagers and sending bond yields and the euro tumbling. The figures also brought warnings that output in the 20-nation bloc will shrink this quarter.
The flash Purchasing Managers’ Index (PMI) for the region fell to 47, further below the 50 threshold indicating growth. Services activity shrank for the first time since the end of 2022, while the expectation was for continued expansion in a sector that had, until recently, seen robust demand. Separate data for the UK showed private-sector firms suffered their first contraction in seven months.
“The PMIs were very weak and highlight the dire outlook for Europe’s largest economy and the risks ahead of the September ECB policy meeting,” said Valentin Marinov, head of G-10 foreign exchange (FX) strategy at Credit Agricole.
The figures were particularly dire in Germany, where overall activity declined at the fastest pace since the first wave of the pandemic brought the economy to a screeching halt in May 2020. France reported a third monthly drop in output, while the rest of the region contracted more moderately.
The data indicate that the Eurozone will shrink by 0.2 percent in the third quarter, compared with 0.3 percent growth in the three months that ended in June, according to Cyrus de la Rubia, chief economist at Hamburg Commercial Bank.
“It strengthens the hands of those arguing for a ‘pause’ in September,” said Dirk Schumacher, an economist at Natixis SA. “The economy is clearly not doing well, given these figures.”
European bonds rallied, with the 10-year German yield falling as much as 12 basis points (bps) to 2.53 percent, its lowest in nearly two weeks. Traders are now pricing in a 40 percent chance of a quarter-point ECB hike next month, compared with 55 percent before the release.
What Bloomberg Economists Say…
“The Governing Council remains worried about upside risks to the inflation outlook, and our current view is that this will prompt them to deliver a last rate hike in September. But signs of a slowdown in the economy may well dominate and force the Governing Council to pause.”
—Maeva Cousin, economist
The euro fell against most of its Group-of-10 peers and reached a one-year low against the pound before the move was pared as weak UK PMI figures dragged the pound sterling down. The euro weakened as much as 0.3 percent against the dollar, to a two-month low at $1.0810, while the pound dropped 0.6 percent, to $1.2650.
“The service sector of the Eurozone is, unfortunately, showing signs of turning down to match the poor performance of manufacturing,” de la Rubia said in a statement. “Service companies reported shrinking activity for the first time since the end of last year, while output in manufacturing dropped again.”
Earlier numbers from Australia pointed to a deepening slump, while a measure for Japan showed solid growth.
Although slowing activity should support an ECB pause, Wednesday’s PMI report also came with a warning over stubborn price pressures:.
Another sharp drop in PMIs is clearly a rude awakening for #ECB hawks at the end of the summer. Problem with a pause is in September is that a pause would actually become the end of current hiking cycle.
—Carsten Brzeski (@carstenbrzeski) August 23, 2023
Headline rates of input cost and selling price inflation moved higher in August, partly due to wages, S&P Global said. The measures still signaled far lower pressures than seen over much of the past two and a half years.
“If core inflation surprises on the upside while the economic outlook is deteriorating, the ECB may be tempted to rush into one last hike in September, which may be effectively their last opportunity to hike,” said Francesco Pesole, FX strategist at ING.
There were also signs that the labor market, which has so far remained resilient against worsening economic prospects, is starting to feel the pinch. Hiring nearly stalled as companies confronted a gloomier outlook for the year ahead, S&P Global said.
Business confidence fell, largely driven by lower backlogs of work. Companies also cited concerns “over broader economic slowdowns at home and in export markets,” the report said.
—With assistance from Mark Evans, Joel Rinneby, James Hirai, Greg Ritchie & Dayana Mustak.
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